Does Mortgage Insurance Pay Off the Mortgage If One of the Owners Dies?

Insurance is one of those things you may not like to pay for –until you need it. It’s also a complicated issue, made worse by the fact that there are so many different kinds of insurance out there. You can insure just about anything these days, including your mortgage. And some policies seem to cover the same things but with slightly different names, like PMI and MPI. Transpose a couple of letters and you have two completely different types of coverage.

A very small percentage of homeowners carry “mortgage insurance,” sometimes called “mortgage protection insurance,” or MPI. Many more carry “private mortgage insurance," known as PMI.

So what’s the difference? A lot. Only one will protect you if your co-owner dies before the mortgage is paid off. Whether you need mortgage insurance in case of death can depend on your estate plan, your health and your job security.

Private mortgage insurance won’t do you a bit of good if your spouse or co-owner dies. In fact, this type of policy doesn’t protect you against anything at all. It protects your lender. Benefits are paid to your mortgage company if and when the policy pays out, not to you.

This type of policy pays the mortgage lender if the borrower defaults on the loan so the lender must foreclose. Typically, benefits equal the difference between the amount the lender resells the property for ultimately and the outstanding mortgage balance. But your lender doesn’t pay the premiums – you must do that.

PMI is almost universally required when you make a down payment on a property of less than 20 percent of its value. Almost all lenders require that you carry PMI if you don’t put enough cash into your home at closing, the rationale being that you’re more likely to default on the loan if you’re not that personally invested in the property. You’ll lose your equity if you default and the lender must foreclose.

You’ll need mortgage protection insurance – or MPI – if you want protection against the death of your spouse or co-owner. Unlike PMI, mortgage protection insurance is optional for homeowners.

MPI protects you against unforeseen calamities, such as the death of the family breadwinner. Think of it like a life insurance policy that’s tied to your mortgage. You pay the premiums on your mortgage life insurance, and the insurer will pay your survivors a normally tax-free benefit should you die.

Your family doesn’t necessarily have to use the money to pay off the mortgage, but they can if they don’t want to have to worry about making those payments without you going forward. And you’ll want to read the fine print because not all policies are created equal. Some do send a check to the lender to pay off your mortgage. Your family won't personally see a dime of the money or have any choice as to how it's used.

There’s a lot in this arrangement for the insurance company. Your premiums will often remain the same for the life of the policy, but the eventual payout will naturally decrease over time as you pay down your mortgage. This is known as a “declining benefit” policy. In fact, these insurers are often affiliated with lenders and you must often purchase the policy through your lender.

With some companies, however, the payout is the amount of the original mortgage balance, no matter how much time has passed and how that balance has reduced. At least one insurer guarantees that the payout will never drop below 20 percent of the original mortgage amount, so again, compare policies.

Some experts suggest that after 20 years or so, you might want to just tuck that premium money in the bank for your heirs rather than give it to an insurance company. It might amount to almost the same amount in the end. Or you might want to purchase a regular life insurance policy as part of your estate plan instead so you can be sure the death benefit goes to your beneficiaries. Life insurance is a “level” plan because benefits remain the same as time goes on. Your family will receive the same amount in benefits whether you die in five years or you live to be 90.

Of course, not every homeowner can qualify for or afford life insurance due to age or health concerns. In this case, mortgage protection insurance can be decidedly useful and can protect against disaster. Then again, if you’re young, hale and hearty, a life insurance policy might be a better value.

Some MPI plans will go a step further and protect you against issues of disability or offer non-medical mortgage protection products that cover job loss. Should one of these events occur, benefits are typically paid to your mortgage company, but not the full amount of your mortgage balance necessarily. Rather, the insurer will make your mortgage payments for you for a period of time, usually no more than a year or two.

Generally, these policy terms only pay the principal and interest portion of your mortgage, not any property tax or insurance escrows that are included in your payment. Still, this can be a lifesaver if you work in a high-risk profession, such as construction, where an injury is more likely so you can’t easily qualify for disability insurance.

Typically, you can purchase either 15- or 30-year MPI terms depending on your mortgage, but it can vary by state law and by the insurer. You might also be required to reapply and initiate a new policy if you refinance your mortgage.

You probably won’t have to concern yourself with finding an MPI insurer when you purchase your home. You’ll most likely be inundated with offers from companies trying to solicit your business when your mortgage becomes a matter of public record. Still, you must sign up for this type of insurance product within a year or two of buying your property. You might not have forever to make the decision.

The good news is that, unlike regular life insurance, you might not have to undergo a medical exam to qualify for a policy. And some insurers will allow you to convert your MPI policy to a regular life insurance policy after a period of time if that suits you better. There may be age requirements, however.

Premiums can run from as little as $50 a month to $150 a month or more depending on the type of coverage you select. For example, the nature and associated danger of your work would most likely be reflected in your premiums if you want to insure against disability.